On the bright side, the fact that markets haven’t ended the European mess by themselves — say, through a truly huge capital flight from the more troubled countries — suggests that a solution does exist in principle, and may even take hold. That isn’t much to cheer about, but, under the circumstances, even simple survival is positive news. One specific bright spot is that both Spain and Greece have been making some wage adjustments to restore longer-term competitiveness.

I grant there has not been comparable progress in reducing suffering. And here is the case for pessimism:

Imagine a situation where the sounder countries need to put up more money, or the troubled countries need to make bigger financial adjustments, or — most likely — both. Yet power vacuums on each side, or voter rebellions against cross-national agreements, could stop these responses from being applied in a timely way. Political paralysis could then become the harbinger of disaster.

The mess won’t be resolved until the various governments raise their hands and announce transparently just how much of the mess they will pay for — and how. Such announcements will then need to be validated by elections. That means sending a consistent message to other countries and to their own domestic electorates and interest groups. Until then, the game of chicken will continue, and the risks of financial catastrophe will remain high.

Overall I still do not think the current arrangement will work out. On the positive side, the political commitment in Greece has turned out to be stronger than I had thought, with the comparable judgment for Spain and Italy remaining up in the air. On the negative side, the broader eurozone recession has halted what was significant progress in Spanish exports.

Finally, I don’t think we will know “the answer” anytime soon:

…the euro zone’s mess could last for a long time, with neither solution nor dissolution.

When matters appear to improve, or when the troubled countries receive more aid, there is more slack in the system. The troubled countries respond by behaving less responsibly and, as a result, move the financial situation closer to the precipice again. For instance, when the European Central Bank announced its debt monetization plans, Spain’s government suddenly faced lower borrowing rates and then refused to apply for a politically costly bailout and austerity package.

When matters become worse, the fiscally healthier countries pony up more aid, as we have seen them do repeatedly for Greece.

It is thus a mistake to overreact to most of the headline events about the euro zone crisis. The good news is never quite as good as it looks, and the bad news often brings beneficial responses. It seems that for dozens of months now, we’ve been hearing that the fate of the euro zone will be decided “shortly,” yet somehow the drama continues.

In normative terms, I see debt forgiveness as essential to moving forward in Europe.

‘The mess won’t be resolved until the various governments raise their hands and announce transparently just how much of the mess they will pay for — and how. Such announcements will then need to be validated by elections.’

Like Germany’s in the fall of 2013?

‘It is thus a mistake to overreact to most of the headline events about the euro zone crisis.’

So, eurogeddon is postponed again? Or at least renamed in principle by the next semi-hysterical, American-centric perspective ‘explaining’ eurozone politics? (Not to mention the additional complicating level of EU politics, which is not the same thing – nobody in the eurozone, for example, cares about the UK, but the UK can block EU wide banking regulations, for example.) Especially considering that many of the generation that guided European integration to its current state believed that only a crisis would provide the necessary impetus for a more united Europe to grow. They may be proved wrong by events – but then, they haven’t been proved wrong yet, at least when looking at today’s EU. A goal of European community which fits this line perfectly, suggesting ‘that a solution does exist in principle, and may even take hold.’

Ray LopezDecember 2, 2012 at 9:30 am

I am impressed by TC’s NYT column ‘even handed’ style. This is usually not desirable for columnists, as extreme positions usually engage more readers. Viz, P. Krugman comes to mind, vs.the Lou Dobbs / O’Reilly / Limbaugh right wingers. As for the game of chicken, it has two Nash equilibria, and from Wikipedia: “Chicken … are anti-coordination games, in which it is mutually beneficial for the players to play different strategies. … Because the loss of swerving is so trivial compared to the crash that occurs if nobody swerves, the reasonable strategy would seem to be to swerve before a crash is likely. Yet, knowing this, if one believes one’s opponent to be reasonable, one may well decide not to swerve at all, in the belief that he will be reasonable and decide to swerve, leaving the other player the winner. This unstable situation can be formalized by saying there is more than one Nash equilibrium …(In this case, the pure strategy equilibria are the two situations wherein one player swerves while the other does not.)”

So, the more reasonable the Greeks are, the more the Germans will push for no debt relief, and vice versa. Hence to get debt relief, which most economists say is desirable, the Greeks should be even more unreasonable. Frankly, I’m surprised (and I’m posting from Athens, GR) how reasonable the GR politicians have been–even the Syriza (anti-EU) party chief is saying GR needs to stay in the euro but needs better debt relief terms. What GR needs is some brinksmanship, and, worse case, they drop out of the EU which is IMO no big loss long term.

MemnonDecember 3, 2012 at 5:39 am

That is where you differ from the Greeks. In their view, dropping out of the EU is a big loss long term. It isn’t really brinkmanship if you actually hold no fear of the abyss. But the Greeks do, and they stepped away from the brink earlier this year when they understood that their partners were very likely to push them over if they got too reckless.

Won’t debt forgiveness just give special interests more time to plunder? The Germans have been completely useless at making loans/debt forgiveness conditional on reform.

I don’t see how debt forgiveness can be useful without growth, and countries like Greece are doing everything in their power to placate special interests and thus limit growth.

BillDecember 2, 2012 at 3:18 pm

Are you looking in the wrong place for reform?

The Euro problems have been framed as a sovereign debt problem, but when you look at several of the countries, the cause of the debt problem is their banking sector–the banks and their debtors became overleveraged–and the state is backstopping or buying bank debt, thereby increasing its own debt.

Only within the last 6 months has there been any effort to regulate banking across the EU, and have a common EU banking backstop.

The age of regulatory competition to the lowest common denominator, and overleveraged financial institutions, is over. Or, at least the governments should bring an end to that chapter.

I think the Eurozone has to a large extend been unfairly bashed by anglo-american economists. They did not think much of it to begin with and might also fear the loss of free goods for paper money called US-$ with the Euro competing as a reserve currency. Making devaluation impossible not only hurts some countries, it also benefits others, which is what is usually forgotten. Statistically the Eurozone has outperformed both the USA and Great Britain over the course of its existence. The bond spreads in the Eurozone went to highly irrational over the course of the crisis as it seems forseeable that the Eurozone will be saved at great costs and the fiscal situation is much better there than in the USA or GB. My take on the situation can be read here:http://makrointelligenzint.blogspot.de/2012/11/is-euro-historic-mistake.html

Anonymous cowardDecember 2, 2012 at 7:53 pm

WTF is a voter rebellion I’d like to know? Presumably if the “rebelling” voters are not enough for a majority it would not be called a “rebellion”, so the “rebelling” voters constitute the majority. But in a democracy it’s meaningless to talk about a “rebellion” of the majority of voters. Who would they rebel against, themselves? Ergo, the locution “voter rebellion” tacitly acknowledges that the countries of Europe are not meaningfully democratic. Congratulations!

prior_approvalDecember 3, 2012 at 5:02 am

A voter rebellion is what happens when the democratically expressed will of the majority simply does not fit what the losers of that vote wanted. The losers of the vote, however, prefer to consider the majority of voters to be rebelling against a natural order, much like the pesky serfs used to. And the losers of such a vote hate to be told they are just throwing a temper tantrum in an attempt to get their way by other means, just like a 2 year old.

A voter rebellion is when the voters insist that the Politicians do the impossible and when they can’t they elect someone else.

BobDecember 2, 2012 at 9:36 pm

I’m curious about this:

“On the bright side, the fact that markets haven’t ended the European mess by themselves — say, through a truly huge capital flight from the more troubled countries — suggests that a solution does exist in principle, and may even take hold.”

What evidence is there to support this? It is my understanding that deposits have fled banks located in at risk countries. This would be portfolio flows which are typically volatile during financial crisis. Other forms of capital aren’t as quick to move so to speak. I haven’t calculated this number so if any knows of somebody who has please post. Also, domestic residents often times repatriate money during crisis as well. My guess is that this is because they are 1) buying back assets from foreigners and 2) need working capital to pay the bills. So, most of the risk financial capital has left and what is left is working capital and other forms not easily moved.

Another point is that the haircut bondholders took could technically be considered capital flight. Foreign residents hold $100 billion in Greek bonds in period 1. After a haircut between period 1 and 2, they now hold $25 billion. Not sure how capital flows are tracked in Europe, but I’m almost positive that under this scenario in the U.S. it would look like U.S. residents were withdrawing capital from Greece. So, the effects could be the same as a capital flow reversal, in other words extremely large. Not to harp on this but if a Greek resident sold the family to a resident of Britain, the transaction would be a wash if the money change hands off shore.

Not sure why more people don’t do research in international money and finance. Still a lot of low hanging fruit in the field but trade seems to get more publicity except for Reinhart and Rogoff.

rreDecember 2, 2012 at 9:58 pm

The size of the bill matters. Seems to me the only way this house of cards can be kept upright is by having the ECB buy up bonds without austerity measures attached, and it seems unlikely the north is going to allow that.

Brian DonohueDecember 2, 2012 at 10:44 pm

I’m trying to balance:

“One specific bright spot is that both Spain and Greece have been making some wage adjustments to restore longer-term competitiveness.”

against:

“The longer that the major players wait, the larger that bill will grow.”

Your article describes a kind of “stable, schlep-along” equilibrium that may endure for years, with spasmodic real adjustments made by the subject countries. Not sure how that’s not a possibility, and a better outcome than settling tabs today.

AidanDecember 3, 2012 at 4:06 pm

“Could all of that happen? For comparison, the current fiscal standoff in the United States involves no more than a president and two houses of Congress. In Europe, however, the bargaining is much more precarious, as it must span numerous nations, many of which have coalition governments, separation of powers and, in the case of Spain and Belgium, significant ethnic and linguistic division. The European Union has even had trouble concluding routine budget negotiations, the disputed parts of which concern no more than 0.03 percent of the union’s gross domestic product. ”

The European Union has been doing things that were considered downright impossible for a long time, in its own incredibly dull and glacially slow bureaucratic manner. For example, it’s easy to forget that the concept of a Franco-German alliance was considered to be about as likely as an Israeli-Palestinian alliance for many centuries. The problem with many otherwise logically constructed arguments as to why the European Union is about to collapse is that they fail to account for how it has survived for this long in the first place. You can’t just write off fifty years of European history as statistically insignificant.

mulpDecember 3, 2012 at 10:44 pm

“In normative terms, I see debt forgiveness as essential to moving forward in Europe.”

On this, a Federal judge has ruled that cram downs on government debt is immoral and illegal, giving hedge funds claims on the government of nations to collect debt. Under US law.

JoeDecember 3, 2012 at 11:10 pm

The thought of Greece or one of the pigs nations dropping out is the intuitive but in this case the wrong prediction of how things will play out. The pigs nations are much better off being in a bad position in the EU and taking advantage of he EU’s welfare than they would be if they dropped out and had to take resposibility for themsves as their own untethered country.

The way it will play out is that the pigs will hang on as long as possible stretching the EU to its fiscal limit, and Germany who is the one flipping the bill for the entire bailout will be pushed too far, will no longer allow itself to be brow beaten by the word “nazi”, and they will drop out.

It is easier to blame the rich than to tell the poor that much of their misfortune is their own doing. Sounds familiar….

chuck martelDecember 4, 2012 at 12:05 am

One hundred and fifty years ago Greeks, Spaniards and Portuguese would be leaving their homes for greener pastures by the shipload. What are the statistics on emigration now? Don’t many of them have relatives in other, at least for the moment, more financially dependable locations in other parts of the world? Isn’t there the possibility that the PIIGS will be left with a population of government employees and entitlement recipients when their entrepreneurs leave?